Oil prices and the budget deficit

An attempt to contain budget, deficit a condition of the IMF

Jan 01 - 14, 2001

The Government of Pakistan (GoP) announced yet another hike in POL prices at the end of December 2000. The decision was vehemently opposed as it was expected to adversely affect the domestic economy and exports due to cost pushed inflation. This increase in prices seems to be a paradox. The rationale given at the time of announcement of price hike seems contradictory to what has been said by Abdullah Yousuf, Secretary, Ministry of Petroleum recently. The general feeling is that the GoP has once again succumbed to the IMF pressure.

As such the GoP is required to review POL prices and adjust them in line with their international prices. Under the IMF Stand-by Agreement signed recently, the GoP committed to review the POL prices on December 15, 2000 and subsequently review the situation on March 15, 2001 and June 15, 2001. According to the official announcement, since the oil prices during the past quarter were still high, though coming down from US$ 33 per barrel to the current level, the GoP considered it appropriate to announce the prices increase. This is a totally absurd rationalization. In reality the prices should have been fixed keeping in view the price trend during January-March 2001 period and not the past prices.

According to reports the recent price hike is part of the agreement with the IMF. The condition was included in the agreement with the IMF and facilitate rescheduling of debt with the Paris Club, besides paving way for loans from other donor agencies. i.e. the World Bank and the Asian Development Bank. According to the agreement with the IMF, the POL prices have to be re-adjusted quarterly, in line with the prices in the international markets. The new prices are based on the daily average of crude oil prices that Pakistan paid for buying oil from the international market during September to November in the previous year.

Many analysts do not accept this rationalization. These analysts say that the IMF only wants from the GoP to meet the condition, reducing budget deficit, and the Fund may be least interested in how it is met. Therefore, the GoP should have followed a more realistic strategy rather than paving the way for cost pushed inflation. According to an economist, "It is true that the IMF wants from the GoP to contain budget deficit to a certain level, but most probably it was the GoP which had agreed to bridge the deficit by increasing the collection under oil development surcharge. The GoP has been following this practice for many years. The rationale was that oil development surcharge is a tax being collected from each individual using POL products and the amount paid by each individual is dependent on quantities of these products."

Keeping in view the conditions of the IMF agreement, regarding budget deficit, one may give the benefit of doubt to the GoP. Pakistanis may bear the higher prices of POL products provided it is only for three months. However, the GoP has to come out with a more realistic revenue collection and contain non-development expenditure to bring collection of oil development surcharge to the least in near future. The GoP must discontinue the practice of dependence on oil development surcharge to meet the shortfall in revenue collection by the CBR.

Crude oil price has been mostly on downward move since last November. It was more than 30 per cent lower compared with its 10-year peak of US$ 37.80/barrel in mid September 2000. The crude oil price registered around 26 per cent decline during December 2000 alone. Therefore, in line with crude oil international prices movement, POL prices should have been decreased after the review in mid December. The decline in price is supported by a recent statement by the Secretary of Ministry of Petroleum. According to the secretary the product wise decline was: HSD (19%), Kerosene (21.7%), Motor Sprit (18%) and Furnace oil (22%). Therefore, there seems to be no justification for the price increase. Now when crude oil prices have come down and range between US$ 25 to US$ 22 per barrel and are expected to maintain downward trend, it is desired that the government should give some relief in middle of March 2001.

The market remains underpinned by the OPEC recent talk on an output cut. OPEC is expected to review its output quota on January 17. It is expected that the decision would be in favour of cutting the quota. Five of OPEC's eleven members have favoured cut in quota. It is expected that despite a cut in quota allocation, there will be an equilibrium in demand and supply and crude oil price may remain in US$ 22 to US$ 25 per barrel range.


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Motor Spirit